Securities Fraud FAQs

What are securities?

Securities are stocks and bonds. A stock represents a share, or percentage, in a corporation's profits and assets. By purchasing stock an investor is buying a percentage of ownership in a company. If the corporation (only corporations issue stocks) makes higher profits, the value of its securities will increase. The shares of the individual investor will gain in worth. When a corporation loses money, however, the value of the investor's shares will decrease. Bonds may be issued by corporations, states, the federal government, and other entities. A bond represents monies loaned to a corporation or issuer. Bonds must be repaid for their full value and usually bring in a specified amount of interest. Holding a bond does not give an investor any ownership in the entity or company, but it will be indebted to him.

What is securities fraud?

Securities fraud occurs when an individual or entity acts in an attempt to illegally manipulate the investment market. Securities fraud may be committed by broker/dealers, financial advisor/analysts, corporations, and private investors. Renewed concern over securities fraud arose during the recent telecom bust. Investors lost millions on Internet companies that had gone from being highly rated and seemingly secure to bankrupt in a phenomenally short period of time.

What is corporate fraud?

When a corporation deliberately conceals or skews information to appear healthy and successful before shareholders, it has committed corporate or shareholder fraud. Corporate fraud may involve a few individuals or many, depending on the extent to which employees are informed of their company's financial practices. Directors of corporations may fudge financial records or disguise inappropriate spending. Fraud committed by corporations can be devastating, not only for outside investors who have made share purchases based on false information, but for employees who, through 401ks, have invested their retirement savings in company stock.

What is investment fraud?

Investment brokers, advisors, and analysts may commit investment or brokerage fraud in an effort to control the market or lure business. The following activities are considered investment fraud when done intentionally:

giving biased investment advice

giving unfounded advice

offering separate clients contradicting advice

advising clients to continue an imprudent risk

advising out of a conflict of interest

Analysts who advised against their research during the telecom bust have faced investigations from the SEC and other state and federal regulators.

What happened during the WorldCom scandal?

WorldCom admitted to adjusting accounting records to cover its operation costs and present a successful front to shareholders. Nine billion dollars in discrepancies were discovered before the telecom corporation went bankrupt in July of 2002. One of the hidden expenses was $408 million given to Bernard Ebbers (WorldCom's CEO) in undisclosed personal loans.

What happened during the Enron scandal?

Investigations against Enron have uncovered multiple acts of fraudulent behavior. Enron used illegal loans and partnerships with other companies to cover its multi-billion dollar debt. It presented erroneous accounting records to investors, and Arthur Anderson, its accounting firm, began shredding incriminating documentation weeks before the SEC could begin investigations. Money laundering, wire fraud, mail fraud, and securities fraud are just some of the indictments directors of Enron have faced and will continue to face as the investigation continues.

What happened during the Tyco scandal?

Shareholders were not informed of the $170 million in loans that were taken by Tyco's CEO, CFO, and chief legal officer. The loans, many of which were taken interest-free and later written off as benefits, were not approved by Tyco's compensation committee. Kozlowski (former CEO), Swartz (former CFO), and Belnick (former chief legal officer) face continuing investigations by the SEC and the Tyco Corporation, which is now operating under Edward Breen and a new board of directors.

What happened during the Merrill Lynch scandal?

Merrill Lynch was indicted for investment fraud following an investigation by N.Y. Attorney General Eliot Spitzer. Evidence was found that Merrill Lynch investment analysts had given favorable coverage to various failing corporations that happened to be Merrill Lynch investment banking clients. Henry Blodget, the company's top Internet analyst, was discovered to have written internal e-mails berating companies that he was publicly giving accolades. Merrill Lynch paid a $100 million settlement to the state of New York in May of 2002. The firm was fined an additional $100 million following further SEC investigations.

What happened during the Smith Barney scandal?

Investigations into Salomon Smith Barney began in 2002. The company's stock ratings were suspected of having been influenced by the desire to win and keep investment banking clients. Jack Grubman, Smith Barney's top Internet analyst, kept his ratings high on telecom stocks through the telecom bust of 2001. In addition to expressing skepticism over the integrity of Smith Barney's ratings, investigators questioned why CEOs and directors of Smith Barney's investment banking clients received IPO opportunities that quickly made them millions.

What happened during the Morgan Stanley scandal?

Morgan Stanley's top Internet analyst, Mary Meeker, is suspected of having kept ratings high for companies she helped bring public. Meeker assisted Morgan Stanley in deciding which companies' IPOs it would underwrite. Her research had a history of being reliable and exclusive (she only covered companies with strong fundamentals); however, as Internet stock values began to fall, her ratings stayed incongruously high when compared to the actual value of the stocks. The firm recently settled investigations by the SEC, and is now facing a suit by LVMH, a luxury fashion conglomerate. LVMH claims that Morgan Stanley published biased research in favor of Gucci, its competitor, out of a conflict of interest.